Capital Budgeting Case Fall 2015 Viking Freight Forwarding Viking Freight Forwar
ID: 2718481 • Letter: C
Question
Capital Budgeting Case
Fall 2015
Viking Freight Forwarding
Viking Freight Forwarding, LLC is a family run operation. It is owned by the Ostrem family, with the 2 Ostrem brothers and 1 sister making up the upper level management team. Tom Bertram, son-in-law of the youngest Ostrem brother, has been hired as the assistant financial vice president of the firm. His primary duties are to evaluate capital budgeting projects and other related long term projects of the operation.
Bertram is currently undertaking an analysis of five major capital budgeting projects for the coming year. All of the projects except for the Ankeny Satellite Terminal project would have the same level of risk as the other long term assets of the firm. Descriptions of the five projects are below and estimate of expected cash flows for each project is outlined in Table 1.
Project Exp2015-A: Expansion of existing facilities at Des Moines Terminal.
Viking Freight Forwarding operates primarily as a bonded freight forwarder, and thus must provide rapid delivery, on short notice, of freight temporarily stored in its bonded warehouse located on Guthrie Avenue on Des Moines’ eastside. The terminal has six existing loading docks and this number is often insufficient for the amount of freight that must be forwarded for prompt delivery.
Because of growth in business, Viking has been unable to meet the needs of its customers on a number of occasions because of backlogs at the loading docks. Firms have begun using other freight forwarders in the area and is starting to have an effect on the revenues of the firm.
Project Exp2015-A calls for the building of an annex to the existing warehouse; the annex would provide 3 new loading docks and 5,000 square feet of additional storage space. This would take some time to construct and the amount of lost revenues would continue to mount so that the recouping the lost revenues would be spread out over a longer time period. However, the additional storage space would allow for more growth in the future.
Project Exp2015-B: Alternative expansion of existing facilities at Des Moines Terminal.
Project Exp2015-Bis to simply add 3 additional loading docks to the existing building. This would significantly reduce the construction time relative to project a so that lost revenues could be recouped faster. However, no additional storage space would be added. Project Exp2015-Bwould disrupt the current operation more and the warehouse layout would have to be reconfigured, so that the total cost of the project would be the same as Project Exp2015-A. While the cash inflows would be more rapid, the projects life would be much shorter. This solves the immediate problem but does not address the growth issue.
Project Exp2015-SAT: Build a new satellite terminal in Ankeny
Rather than expanding at the current Guthrie Avenue location, Bertram is considering building a satellite terminal in the industrial park in Ankeny which is located 6 miles from the current location. The current site in Des Moines does not have the potential for extensive expansion so he is considering this expansion in an off-site location. This is a much more expensive project and more risky in that excess capacity will be built and coordinating shipments will be more difficult
Project TT2015-A: Purchase of Three New Tractor-Trailers.
An increase in business has not only caused backlogs at the loading docks but also has forced Viking to lease tractor-trailers since they have insufficient quantity of their own. This increases the cost of transportation as well as making it difficult to do regularly scheduled maintenance on their tractor-trailers since they are being fully utilized with little down time. Project TT2015-A would alleviate this problem.
Project BH2015-A: Special equipment for handling bulk commodities.
A profitable capital investment made in 1990 to handle bulk commodities and forward them by rail would be upgraded under Project BH2015-A. This would involve the installation of a movable conveyor belt to increase rail car loading efficiency by reducing current labor costs.
Table 1
Mutually
Exclusive
Independent
Independent
Project
Project
Project
Project
Project
Exp2015-A
Exp2015-B
Exp2015-C
TT2015-A
BH2015-A
CFo
$(750,000.00)
$(840,000.00)
$(2,600,000.00)
$(1,250,000.00)
$(720,000.00)
1
$ 195,000.00
$ 275,000.00
$ 625,000.00
$ 258,900.00
$ 261,900.00
2
$ 225,000.00
$ 295,000.00
$ 650,000.00
$ 258,900.00
$ 261,900.00
3
$ 214,500.00
$ 315,900.00
$ 750,000.00
$ 258,900.00
$ 261,900.00
4
$ 216,500.00
$ 200,000.00
$ 750,000.00
$ 258,900.00
$ 261,900.00
5
$ 229,400.00
$ 110,000.00
$ 775,000.00
$ 258,900.00
$ 261,900.00
6
$ 219,400.00
$ 90,000.00
$ 800,000.00
$ 258,900.00
7
$ 210,400.00
$ 90,000.00
$ 675,000.00
$ 258,900.00
8
$ 205,400.00
$ 80,000.00
$ 650,000.00
$ 258,900.00
9
$ 195,400.00
$ 80,000.00
$ 625,000.00
$ 258,900.00
10
$ 185,400.00
$ 70,000.00
$ 500,000.00
$ 258,900.00
Note all cash-flows are on an after tax basis.
The existing capital structure uses very little debt and relies mostly on retention of earnings and additional equity provided by the Ostrem family. While Bertram believes that the cost of capital could be reduced by changing the capital structure to include more debt, the current capital budget must be analyzed using the existing capital structure and the relevant component costs. See Table 2 for the cost of capital and the current capital structure.
Table 2
Cost of capital and capital structure
Component
weight
cost
Present
Debt
40%
7%
Common Equity
60%
14%
Tax rate =30%
Requirements:
Compute the weighted average cost of capital for the firm.
Simply, without consideration for the life of the projects, calculate Payback, NPV, IRR, Profitability Index and MIRR for each project using the current cost of capital. Assume the reinvestment rate for MIRR is the weighted average cost of capital for the firm.
Based on your computations in requirement number one, which projects should be accepted? Note: Projects Exp2015-A, Exp2015-B and Exp2015-C are mutually exclusive.
Table 1
Mutually
Exclusive
Independent
Independent
Project
Project
Project
Project
Project
Exp2015-A
Exp2015-B
Exp2015-C
TT2015-A
BH2015-A
CFo
$(750,000.00)
$(840,000.00)
$(2,600,000.00)
$(1,250,000.00)
$(720,000.00)
1
$ 195,000.00
$ 275,000.00
$ 625,000.00
$ 258,900.00
$ 261,900.00
2
$ 225,000.00
$ 295,000.00
$ 650,000.00
$ 258,900.00
$ 261,900.00
3
$ 214,500.00
$ 315,900.00
$ 750,000.00
$ 258,900.00
$ 261,900.00
4
$ 216,500.00
$ 200,000.00
$ 750,000.00
$ 258,900.00
$ 261,900.00
5
$ 229,400.00
$ 110,000.00
$ 775,000.00
$ 258,900.00
$ 261,900.00
6
$ 219,400.00
$ 90,000.00
$ 800,000.00
$ 258,900.00
7
$ 210,400.00
$ 90,000.00
$ 675,000.00
$ 258,900.00
8
$ 205,400.00
$ 80,000.00
$ 650,000.00
$ 258,900.00
9
$ 195,400.00
$ 80,000.00
$ 625,000.00
$ 258,900.00
10
$ 185,400.00
$ 70,000.00
$ 500,000.00
$ 258,900.00
Explanation / Answer
Weighted average cost of capital
Sourece Proportion weight Cost of capital cost of capital
(a)Debt 40% .4 4.9% (after tax) 1.96%
(b)Equity 60% .6 14% 8.4%
Weighted average cost of capital =(a+b) 10.36%
calculations of Option 1
project 4
S
Summary sheet of all the Proposals
MIRR 16%
Project 2
10
option no 5
69%
16%
Cash Outflow -750000 cumulative cash inflow PV@10.36% Sum of discounted cash Inflow 195000 195000 0.906125 176694.5 225000 420000 0.821063 184739.2 214500 634500 0.743986 159585.1 216500 851000 0.674145 145952.4 229400 1080400 0.61086 140131.2 219400 1299800 0.553516 121441.3 210400 1510200 0.501555 105527.1 205400 1715600 0.454471 93348.41 195400 1911000 0.411808 80467.28 185400 2096400 0.37315 69181.95 Pay Back Period 3 Paby Back Period 0.533487 3.533487 Sum of discounted cash inflows 1277068 Sum of discounted cash outflow 750000 NPV of the Project 527068.4 Profitability Index sum of discounted cash inflow/ outflow 1.702758 IRR of the Project 26.98% MIRR 98% cumulative cash inflow PV@10.36% Sum of discounted cash Inflow Inflow 1 195000 0.880282 171654.9 2 420000 0.774896 174351.6 3 634500 0.682127 146316.2 4 851000 0.600464 130000.4 5 1080400 0.528577 121255.6 6 1299800 0.465297 102086.1 7 1510200 0.409592 86178.2 8 1715600 0.360557 74058.31 9 1911000 0.317391 62018.26 10 2096400 0.279394 51799.6 3 0.533487 3.533487 1119719 750000 369719.1 1.492959 25.97%project 4
-1250000 cumulative cash inflow PV@10.36% Sum of discounted cash Inflow 258900 258900 0.906125 234595.9 258900 517800 0.821063 212573.3 258900 776700 0.743986 192618 258900 1035600 0.674145 174536.1 258900 1294500 0.61086 158151.6 258900 1553400 0.553516 143305.2 258900 1812300 0.501555 129852.5 258900 2071200 0.454471 117662.6 258900 2330100 0.411808 106617.1 258900 2589000 0.37315 96608.45 Pay Back Period 3 Paby Back Period -0.10313 2.896871 Sum of discounted cash inflows 1566521 Sum of discounted cash outflow 1250000 NPV of the Project 316520.7 Profitability Index sum of discounted cash inflow/ outflow 1.253217 IRR of the Project 25.42% MIRRS
Summary sheet of all the Proposals
5 Project A Project B Project c Project D Project E Final Decision Pay BacK period 3.53 Years 2.32 1.3 2.896871 2.86 Project C as it is having lowest PBP NPV 527068 278826.1 1557757 316520.7 263743 Project A as per NPV Method PI 1.7 1.33 1.59 1.253217 1.36 Project A As per PI method IRR 26.98% 22.98% 25.42% 18.47% 25.33% Project A highest IRR MIRR 98.00% 27% 47% 52% 69% Project A Highest MIRR 2%MIRR 16%
Project 2
1.136 Cash Outflow -840000 cumulative cash inflow PV@10.36% Sum of discounted cash Inflow Inflow 1 275000 275000 0.906125 249184.5 2 295000 570000 0.821063 242213.7 3 315900 885900 0.743986 235025.3 4 200000 1085900 0.674145 134829 5 110000 1195900 0.61086 67194.58 6 90000 1285900 0.553516 49816.4 7 90000 1375900 0.501555 45139.91 8 80000 1455900 0.454471 36357.7 9 80000 1535900 0.411808 32944.64 10 70000 1605900 0.37315 26120.48 Pay Back Period 3 Paby Back Period -0.6795 2.3205 Sum of discounted cash inflows 1118826 Sum of discounted cash outflow 840000 NPV of the Project 278826.1 Profitability Index sum of discounted cash inflow/ outflow 1.331936 IRR of the Project 22.98% MIRR 27%10
option no 5
-720000 cumulative cash inflow PV@10.36% Sum of discounted cash Inflow 261900 261900 0.906125 237314.2 261900 523800 0.821063 215036.5 261900 785700 0.743986 194850 261900 1047600 0.674145 176558.5 261900 1309500 0.61086 159984.2 0 1309500 0.553516 0 0 1309500 0.501555 0 0 1309500 0.454471 0 0 1309500 0.411808 0 0 1309500 0.37315 0 Pay Back Period 3 Paby Back Period -0.13631 2.863688 Sum of discounted cash inflows 983743.4 Sum of discounted cash outflow 720000 NPV of the Project 263743.4 Profitability Index sum of discounted cash inflow/ outflow 1.36631 IRR of the Project 25.33% MIRR69%
500000 6800000 0.37315 186574.8 Pay Back Period 3 Paby Back Period -1.7 1.3 Sum of discounted cash inflows 4157757 Sum of discounted cash outflow 2600000 NPV of the Project 1557757 Profitability Index sum of discounted cash inflow/ outflow 1.599137 IRR of the Project 25.42% MIRR 47%16%
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